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5 Big Mistakes Investors Make -- And How To Avoid Them

Like the vast majority of people, you probably think you’re above average.

Although it’s impossible that the vast majority of people outshine half their peers, illusory superiority, as the phenomenon is called, is alive and well.

Take, investing for example. Many people think they can get some kind of competitive edge that will allow them to outperform the market. But studies show that the majority of investors actually underperform the market — and one reason could be that they are trying to time their investments to achieve the greatest returns. Instead, they get in and out at suboptimal times.

One group of DIY investors, however, doesn’t try to time their investments. The Bogleheads, a forum of passionate low-cost investors who espouse the philosophy of John Bogle, founder of low-cost investing firm Vanguard, is willing to accept average market returns, knowing that they’ll still pull ahead of most other investors by keeping their investing expenses low. (Click here for a summary of the Bogleheads’ investing philosophy.)

At their 12
th conference in mid-October, Joel Dickson, Vanguard’s senior investment strategist and principle, talked about five “crazy” things investors do. Here are those pitfalls, along with tips for avoiding them.

1. Sloth: ‘Why Do Today What You Can Do Tomorrow?’

When it comes to long-term savings, especially retirement savings, it’s best to invest it as soon as you can, because time is key to allowing your money to grow over the long term. Also, because of the difficulty of timing the market, it’s best not to put all your money in at once, but to invest a little bit every week so that if you buy high one week, it will be offset later when the market dips and you buy low.

While you probably already knew both these tips, it turns out that many investors are doing the exact opposite. In case you hadn’t heard before, contributions to your Individual Retirement Account are capped every year, with $5,500 being the limit for tax year 2013. If you don’t contribute the full amount by December 31, however, you’re allowed to make “late” contributions from January 1, 2014 to April 15, 2014 for the previous tax year.

And, in fact, Dickson says that two-thirds of investors do exactly that. This means that the majority of investors are losing out on the gains from the year before, plus not averaging out the price at which they’re buying their investments.

If this is you: Automate your best money behaviors. For instance, if you are guilty of investing late to your IRA, put $211.54 in the account every other week, to reach a total of $5,500 by the end of the year.

2. Impatience/Impulsiveness: ‘That Grass Looks Greener.’

“Investing is one of the few places where people don’t like to buy things when they’re on sale,” Mel Lindauer, one of the moderators of the forum, told me for my story on Boglehead investing principles.

And indeed, Dickson showed evidence that people tend to buy high and sell low. Why? A mixture of impatience and impulsiveness. The end result is that they consistently underperform the very funds they are invested in, which is largely a case of getting in and out at the wrong times.

“The more specialized the investment, the bigger the gap between the investment return and the investor return,” he said, as you can see in the chart below:

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